Accrual Basis of Accounting

Unlike book-keeping, which includes the storage of various finance-based transactions in multiple books, accounting consists of the maintenance of accounts or financial data of an individual or a corporation based on the recorded data and the interpretation of data. An accounting system is a basic and trending way of collecting data from a large scale body. It is commonly defined as collecting, analyzing, summarising, and reporting in terms of finance, all the company’s business. Accounting aims to know the company’s financial result, that is, the profits and losses gained by the enterprise over some time.

Accrual Basis of Accounting

The Accrual Basis of Accounting concept is very simple to grasp and understand. Accrual Basis of Accounting is the process of a business transaction or transactions that are recorded when they happen or occur. They are not recorded when any business-related payments or receipts are made or received. 

This concept is called the Accrual Basis of Accounting, and this type of accounting is extremely useful and fundamental for financial accounting information.

In easy words, revenue is recognized when earned and realizable. 

Some Accrual Basis of Accounting: Examples

Here are some examples to help an individual understand the accrual concept in accounting or what is accrual basis of accounting is-

An airline makes its tickets available for flights, months and weeks before the actual departure of the flight or the day the flight is determined to fly; the airline does not record any of the payments which are made as to their source of income or revenue because the flight or the event has not yet taken off. The event for which money was paid has not commenced yet, so a transaction will not be accounted for. 

A company records all utility bills as soon as it receives them and not when they are paid because the service has already been used. The company then ignores all the data once the payment is made.

To make it easy for understanding the accrual concept in accounting –

Let us assume that an appliance store sells a Microwave to a customer on credit terms. Then based on the terms of the agreement between the buyer/ customer and the company, the customer can take a few months or years to pay his part to the store for buying the microwave. 

Depending on the accrual accounting method, the store will now record the accrued revenue for the sale when the microwave leaves the store, not at any convenient date in the future.

An accrual basis of accounting is of different types- Accounts payable accrual accounting, accounts receivable accrual accounting, goodwill accrual accounting, accumulated interest earned accrual accounting, and accrued tax obligations accrual accounting. Accounts payable accrual accounting refers to the debts incurred by a company when it gets goods or services from sellers before paying completely for them. 

When a corporation incurs an expense, the debt is recorded on the balance sheet as an accounts payable obligation and on the income statement as an expense using the accrual method.

Difference between a Cash Basis Accounting and an Accrual Basis Accounting

Benefits of Accrual Basis of Accounting

The accrual techniques provide an accurate view of the company’s present state. At the same time, it’s more than expensive to adopt due to its complexity. The growing complexity of all the corporate transactions and the demand for precise and accurate financial data lead to the development of the accrual system. 

The financial state of a corporation or a company at the time of a transaction is affected by sales on credit as well as projects that produce revenue streams for a longer period. Thus, it’s only natural that such events are represented in the financial statements at the same reporting time period as the transactions that took place.

Accrual accounting gives businesses instant information on predicted cash inflows and cash outflows, making it easier to manage existing resources and prepare for the future.

Conclusion

The Accrual Basis of Accounting is extremely useful and fundamental for financial accounting information. In easy words, revenue is recognized when earned and realizable. The accrual basis of accounting has comparatively more benefits than a cash-based accounting system. Suppose an individual is not sure whether to utilize cash accounting or accrual accounting for their company. In that case, it is indeed a good idea to get a piece of advice from a financial professional. 

A financial expert will explain all of the advantages of accrual accounting. This will allow an individual to see if accrual accounting is a good fit for their firm. A financial expert can also show a person how to use the accrual accounting method in their company.